Japan beckons

The Invesco Japan Discovery Trust (IJD) is a UK investment trust which was launched in August 1994 on the London Stock Exchange. Its objective is to provide long term capital growth (as opposed to income) by investing in a diversified portfolio of smaller Japanese companies, primarily listed on the second section of the Tokyo Stock Exchange and the regional exchanges of Japan. The overall goal of the Trust is to achieve growth in Net Asset Value in excess of the Tokyo Stock Exchange Second Section Index (sterling adjusted).

The trust is managed by Invesco out of its Tokyo office. As at the 31 August 2003, the fund had total gross assets of £20 million, and a net asset value per share of 69.0p. The trust is ungeared and also benefits from low annual costs.

The largest shareholdings include stakes in the following companies: Index Corp (5.5 percent of the portfolio), UMC Japan (5.5 percent), Disco (5.2 percent), Shinkawa (5.1 percent), Thine Electronics (4.8 percent), Arrk Corp (4.2 percent ), Kappa Create (4.2 percent), C Uyemura (4.2 percent), Askul Corp (4.1 percent), and En Japan (3.8 percent). The Manager has been set guidelines by the Board that it should invest only in those companies that fall within the bottom quartile in market capitalisation. In our opinion, these companies can react quickly to market changes and are well placed to benefit from Japan's economic recovery.

The listed units have performed poorly for the past three years in terms of share price and asset backing, which directly reflects the poor performance during the same period of the Japanese equity markets. In fact, for the past two years the units recorded negative returns both in terms of movement of the listed price as well as the movement in net asset value. This is not surprising given that there have been negative movements during the same period in the Nikkei and the Tokyo Stock Exchange First Section (TOPIX). In addition, over this period, the Japanese Yen appreciated against sterling by some 5.4 percent. However IJD was hedged for much of this period, and made around £197,000 from hedging contracts.

Valuations of the Japanese markets continue to be adversely affected by the poor domestic economic situation in Japan. This has been exacerbated by the precarious global economic situation. Accordingly, the emphasis of the trust continues to be on seeking out small growth orientated companies operating in niche markets.

While it has to be said that the outlook for global economic growth remains subdued at best, and the much needed and talked about reform of the Japanese banking sector has yet to take place, we believe that we are now approaching the time when investing into the Japanese markets makes sense. The Nikkei recently slumped to a twenty low, when in January, the Nikkei Index closed below 8,400 for the first time. This was largely due to concerns about the viability of the banking and insurance sector in the run up to the 31 March year end. Due to the banks' large equity holdings, any fall in general share prices will further impact on their financial strength, and will endanger their capital adequacy. Positive steps have been taken by Japan's financial regulator to stimulate the stock market, such as making it easier for companies to buy back their own shares or to set voluntary rules for the lending of shares. All these measures are providing a useful "backdrop" to a general recovery in the market.

As would be expected, IJD has a strong correlation to the Nikkei. The recent strength in the Japanese index has been positive for IJD, with the shares rallying off their lowest level in four years. We believe that a lasting low is in place at 40p, and over the coming twelve months, solid upside potential exists.

IJD tends to seek out growth opportunities at the smaller to medium sized end of the market and we view this as a suitable vehicle for providing exposure to the recovering Japanese equities markets. At the current price, the listed units provide an 18 percent discount to current net asset backing, which represents an inexpensive entry into the market. Furthermore, the dominant pattern on IJD's charts is a downward trend channel that has contained the share price since early 2001. The latest price action has seen IJD break to the topside of this pattern, which is highly significant, and clears the way for further gains in the months ahead. Accordingly, we recommend that Members buy IJD up to 63p.